Volume 17, No. 6

The FASB Wades Into The Securitization SwampOpinions vary as to the current state of the credit crisis: we’re near the end or we’re somewhere in the middle, depending on whose data you believe. Regardless of the progress made, one fact is clear: when the credit party was in full swing, it was hard for regulators to monitor all the bad loans made. That’s because they were cleared off lenders’ balance sheets as soon as they were made through the alchemy of securitization, where illiquid assets like mortgages and receivables are packaged into bond-like securities. Once those securities are dispersed through the financial system, it’s hard to tell where the damage resides. The underlying mortgages go sour, and so do the securities that may have traded many positions away from the initial securitization.

The accounting for securitizations is either simple or overly complex. If firms treat securitization transactions as secured borrowings, the accounting is simple. Should firms treat securitizations as a sale of assets, the accounting is tortured to make it fit into the concept of a sale. The sale treatment may have contributed to the current financial distress: if securitizations accounted for as sales had been more accurately accounted for as financings, balance sheet leverage might have limited securitizations of the more treacherous assets.

As so often happens with accounting standard-setting, it’s time to fix the barn door: the horse is three counties away. In January, the SEC acted schizophrenically on securitization accounting. On one hand, it promoted the continuance of the tangled accounting model in Statement 140 by giving a bye to lenders who renegotiate mortgage loans already sold in securitization transactions; on the other hand, it instructed the FASB to fix the underlying principles in Statement 140 that have caused issues. The FASB is close to issuing possible changes to Statement 140 that, if enacted, would cut the number of new securitizations earning sale treatment - but the fix is not going to be pretty or popular with either preparers or auditors. Without widespread acceptance, it’ll be hard for FASB to get the fix in place by year end.